United States: final regulations issued to prevent tax avoidance in stock acquisitions by related corporationsJanuary 23, 2013
The US Treasury Department and the Internal Revenue Service (IRS) have issued final regulations (TD 9606) to prevent tax avoidance in connection with stock acquisitions by related corporations under section 304 of the US Internal Revenue Code (IRC).
IRC section 304 is intended to prevent the use of stock sales between brother-sister or parent-subsidiary corporations as a means to produce capital gains rather than dividend treatment.
Specifically, IRC section 304(a)(1) provides that, if a corporation (acquiring corporation), in return for property, acquires stock in another corporation (issuing corporation) from a transferor in control of each of the two corporations, property received by the transferor is treated as a distribution in redemption of the stock of the acquiring corporation.
The redemption is then analyzed under the tests described in IRC section 302(b), which are intended to distinguish a true stock redemption (treated as a sale) from a distribution of corporate earnings. If none of the tests are met, the transaction is treated as a corporate distribution with possible dividend consequences, rather than as a sales transaction.
In determining the amount of the corporate distribution that is a dividend, the earnings and profits (E&P) of both the acquiring corporation and the issuing corporation are taken into account under IRC section 304(b)(2). IRC section 304(b)(5) limits the amount of E&P of a foreign acquiring corporation that are taken into account for this purpose.
Under IRC section 301(c)(2) and (3), if the amount of the distribution exceeds the combined E&P of the acquiring corporation and the issuing corporation, the excess reduces the transferor’s basis in the stock and is treated as a tax-free return of capital to that extent and as gain from a sale of the stock to the extent of any further excess.
It was observed that some taxpayers attempted to eliminate the amount of a distribution constituting a taxable dividend artificially by, for example, having an existing corporation with a positive E&P account form a new corporation with no E&P and having the newly formed corporation (acquiring corporation) acquire the stock of an issuing corporation using the capital contributed by the existing corporation (deemed acquiring corporation) to form the acquiring corporation.
On 14 June 1988, the Treasury Department and the IRS promulgated Treasury regulation section 1.304-4T (TD 8209) to treat the deemed acquiring corporation as having acquired the stock of the issuing corporation if the deemed acquiring corporation controls the acquiring corporation and the acquiring corporation was created, organized, or funded primarily to avoid the application of IRC section 304 to the deemed acquiring corporation.
On 30 December 2009, temporary regulations (TD 9477) and proposed regulations (REG–132232–08) were issued to extend the application of the anti-abuse rule of Treasury regulation section 1.304-4T to a “deemed issuing corporation.”
A deemed issuing corporation refers to a corporation that is controlled by an issuing corporation, if the issuing corporation is a newly formed corporation having no E&P, and having acquired the stock of the deemed issuing corporation in connection with the acquisition of the stock of the issuing corporation by an acquiring corporation with a principal purpose of avoiding the application of IRC section 304 to the deemed issuing corporation.
The acquiring corporation then will be treated as acquiring the stock of the deemed issuing corporation subject to the regular IRC section 304 analysis described above.
The final regulations adopt the 2009 temporary regulations without change. The final regulations are designated Treasury regulation section 1.304-4.
The final regulations are effective on 26 December 2012 and apply to acquisitions of stock occurring on, or after, 29 December 2009.
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